Wattle Watch

In any given month, Wattle Partners meets with many different professionals offering a new investment product, idea or scheme. Most are a pass from us, but now and again some pique our interest. 

 

It was the day before Christmas and we had arranged to meet with a relatively unknown group to us, called GQG Partners. After hesitantly accepting the meeting we were happily surprised by the quality of the manager and wondered how it had passed us by thus far.

GQG stands for Global Quality Growth and that is exactly what they appear to have been delivering. The group was founded by Rajiv Jain, who has 26 years’ experience in funds management, having run the emerging markets and global equity strategies at the renowned Vontobel Asset Management. As is the case with most of the world’s top equity managers, Rajiv started the company because he wanted to be able to invest his own capital in the strategy but also have ownership of the business itself, both gains and losses.

GQG has been operating since 2016 but already has over $42bn under manageemnt across global equities ($18bn), emerging market equity ($12bn) and international, specific equity strategies ($12bn). As is generally the case, the fund is well backed by institutional and pension fund investors, including a number of Australian super funds, but has had little penetration into the direct investor and adviser market. The domestic managed funds on offer have $158m (global equity) and $100m (emerging markets) respectively under management. This is despite delivering benchmark leading returns of 20% (compared to 16%) and 28% (versus 15%) for both strategies over the last 12 months.

The firm has a number of unique traits that appear to have driven the outperformance, which begin with their approach to identifying ‘forward looking quality’. This is opposed to the traditional approach of using backward looking financial results to determine forward looking value, rather they put in place conservative assumptions of business performance to understand risks and cyclicaly in the next five to ten years.

The other key differentiating point is the Rajiv’s inclusion of a number of Investigative Journalists on his investment review team. It is the role of these people to question every aspect of a thesis on a company being prepared for addition to the portfolio, asking questions of suppliers, customers and travelling heavily to understand supply chains.

The portfolios are low turnover, diversifed across 40 to 60 holdings and span both value and growth investments, ensuring there is little commonality with the benchmark.

As advisers, one of the most difficult investment opportunities to find are high quality exposures to emerging markets, GQG seems to have an extremely competitive offering and we will provide more information in future issues.

Nike Inc.

This month we undertake a quick review of Nike Inc. one of the best performing companies in the US in 2019 and a core holding within the Aoris Fund discussed above.

We all know Nike from its ubiquitous swoosh logo, and whilst the company remains the biggest shoe producer in the world, they are mich more than that. The company was originally founded in 1964 by the now billionaire Phil Knight, it apparently takes its name from the Greek Goddess of Victory, Nike. Nike is the basic marketing guru’s example of how important branding can be in an incredibly competitive market. Today, the company has expanded substantially from its beginnings, with brands and athletes spanning almost every global sport from Golf to Basketball and Ice Hockey. Nike owns the timeless Jordan Brand and is well known for being the winner of the Jordan Sweepstakes before he embarked on the greatest career in the history of professional basketball. But enough history, we need to consider the financials.

Nike recently reported their second quarter’s results, managing to buck the trend of slowing growth in what is apparently a mature industry. The company saw revenue growth of 10% on the previous quarter to $10.3bn, driven by growth across all geographies. Nike managed to improve their gross margin in the quarter, bucking the trend of their competitors, and was able to leverage 10% revenue growth into 35% earnings per share growth. The company highlighted their investments into constant product innovation and the digital transformation of their production, marketing and distribution. Looking more closely, the core Nike Brand continues to represent the majority of revenue, $9.8bn, up to 12% in constant currency terms, whilst Converse grew 15% to $480m with the momentum coming from its expansion into Asia and growth in Europe.

Nike is increasingly focusing on its global branding, having identified the opportunities in the Asian Middle Class Thematic, which is core to Wattle Partners approach. Their financials indicated that China was one of the fastest growing regions, with total sales improving 20% on quarter, and profit up 24%.

Aoris International Fund

Aoris is a specialist global share manager founded in 2017 by Stephen Arnold. Stephen previously managed the Evans & Partners Global Equity Strategy from 2011 to 2017, delivering a return of 18.3% per annum with over $1bn in assets under management. Stephen founded Aoris in an effort to bring his successful investment strategy to a broader group of investors.

What’s the fund?

This month we are reviewing the Aoris International Fund, which is a long-only global equity strategy. Aoris are unique in that they have a high conviction approach, holding just 10 to 15 companies and provide transparency into every investment at all times. Aoris have identified that avoiding the companies that fall into the bottom 20% of the market in any given year is the closest thing to guaranteeing outperformance. They understand that the poorest performers typically suffer from high debt levels, inflated valuations and poor returns on investment capital, which are key considerations of the team.

Why Aoris?

Aoris’ differentiating point is simplicity, and a focus on finding high quality companies. The research team achieves this by excluding a number of more popular sectors from the universe of opportunities. For example, Aoris will not invest in businesses with high leverage (financials/banks), low return on invested capital (energy), cyclical revenue (mining), regulated income (utilities), opaque (healthcare), narrow product offerings (IT) or commoditized products (retail). The result is that Aoris portfolio is tilted towards service providers and traditional industrial or diversified companies that are more suited to negotiating difficult economic periods. The result is a portfolio of high quality companies, operating in diverse industries offering true diversification.

Where does it fit in your portfolio?

Aoris meets the objective of the Value Bucket as the fund seeks to generate a return of between 8-12% per annum, with just 1-2% coming from dividends. This objective return is achieved by targeting companies offering 6-7% annual growth in their intrinsic value, or more importantly their profitability, 1-2% from dividends and 2-3% from market revaluations. More simply, the fund focuses on buying businesses that are growing earnings and revenue, not one or the other, and which have both breadth and diversification of those revenue streams, removing any cyclicality.

Why Invest?

Aoris exhibits two of the most important characteristics of successful active fund managers; low portfolio turnover and high active share. Low turnover is driven by their core, high conviction portfolio whilst active share relates to the fact that the underlying portfolio differs substantially from the benchmark index. The Aoris Fund will complement the alternative global funds in most portfolios due to the substantial difference in underlying investments. The fund will not hold the likes of Facebook, Amazon, or the major banks, due to their strict screening process, meaning there will be limited, if any, overlap with the other funds in your portfolio. The management team have shown a unique and repeatable ability to identify companies with economic and competitive resilience, even during the worst of times, and their focus on return on invested capital, continues to be a driver of real value in an increasingly expensive market.

The fund charges a competitive management fee of 1.1% plus a performance fee of 15%. We have successfully negotiated a discount to this fee on behalf of all clients of Wattle Partners.

What does it invest in?

Aoris will only buy and hold individual companies, they will not bet on companies falling in value. The portfolio is highly concentrated, at 10-15 holdings, meaning every investment will have a real impact on the performance of the portfolio. At present, the key holdings are spread across the globe, but with 51% of revenue coming from the US, 23% from Europe and 17% from Asia. These holdings include global luxury business Louis Vuitton Moet Hennessy (LVMH), make-up and skincare retailer Loreal, consumer credit reporting company Experian, consulting business Accenture and sportswear brand Nike.

How has it performed?

The fund is a long only strategy, meaning The fund delivered a return of 18.7% for the 12 months to August 2019, outperforming the MSCI benchmark which returned just 7.0%. Importantly, the fund has not had a single holding in the bottom 20% of the market since its inception.

Transfer Balance Cap

By Annabelle Dickson

The Australian Taxation Office (ATO) is alerting superannuation trustees to plan for a number of changes in regard to the indexation of the general transfer balance cap, which will be particularly important for SMSF trustees.

The transfer balance cap is expected to rise to $1.7 million on 1 July 2020 in line with the consumer price index (CPI), bringing changes to the limits of non-concessional contributions, co-contributions and spouse offset.

The cap is currently $1.6 million of the total amount of accumulated superannuation an individual can transfer into the tax-free retirement phase. Retirees commencing a retirement phase income stream after indexation will have the full increased transfer balance cap of $1.7 million. However, for those who have already commenced a retirement phase income stream, the cap will be proportionally indexed based on the highest ever cap balance.

Peter Hogan, head of technical at SMSF Association says: “It is complex because everyone’s transfer balance cap will be different. You can only index the unused amount of the transfer balance cap.”

The ATO says it will calculate the entitlement to indexation and the personal transfer balance cap after indexation, based on the information reported to and processed by them when indexation occurs.

In the case that the balance in the transfer balance account was $1.6 million or more after 1 July 2017 and between the time of indexation, the cap will not increase. Graeme Colley, executive manager, SMSF technical and private wealth at SuperConcepts, says that these changes will affect all superannuation members in pension phase but may affect SMSFs more due to members having higher non-concessional contributions and larger total superannuation balances.

Hogan agrees and says it is important that SMSF trustees understand how much they have used and apply the indexation to what is unused. Colley says: “What may happen with SMSFs is that members will continue putting in contributions as they always have been and may forget about the rules, so mistakes can arise. The ATO is sensible in getting this information out now for the potential indexation to try and avoid that.”

The total superannuation balance limit which determines if an individual is not allowed to make non-concessional contributions will increase from $1.6 to $1.7 million.

In addition, an individual qualifying for a co-contribution entitlement will cut out when their total superannuation balance reaches $1.7 million and above. The limit that excludes an individual from claiming the tax offset for superannuation contributions they make on behalf of their spouse will rise from $1.6 to $1.7 million.

Despite the limits increasing to the same amount, there is a disparity in the way that the contributions are indexed. Colley says: “The transfer balance cap is indexed at CPI but the concessional and non-concessional contributions are indexed at changes in average ordinary times earnings (AWOTE). AWOTE indexation occurs at a greater rate than CPI in nearly all situations.” Hogan agrees: “CPI is less generous than AWOTE and takes longer to get to the same level.”

If indexation does not occur on 1 July 2020, the ATO anticipates it will occur on 1 July 2021

Annabelle Dickson is a journalist at The Rub and The New Investor.

Listed Investment Companies

One of the topics gaining the most attention in December and over the Christmas break was the proliferation of listed investment companies that have emerged in recent years. The sector has doubled in size following its exemption from the Future of Financial Advice Reforms, as they allowed fund managers to pay advisers, stockbrokers and accountants ‘stamping fees’ of up to 6% of the amount invested by their clients. Sounds very similar to the likes of Great Southern and Timbercorp doesn’t it.

As we have seen in history, whenever there is a loophole available, it will be leveraged by interested parties. The sector attracted attention after Chris Joye from Coolabah Capital provided an in-depth analysis (below) whilst news was released about Treasurer Frydenberg’s briefing on the subject in 2019. Interestingly, little has been done about the issue and ASIC is essentially powerless from protecting investors from being ripped off due to the loop hole. What follows is Chris Joye’s most recent column on the sector and recent changes.

A revolution is coming for conflicted financial advisers – Coolabah Capital

In one of the biggest shake-ups of the financial advice industry in years, the government’s Financial Adviser Standards and Ethics Authority has blanket-banned conflicted sales commissions, including previously acceptable “stamping fees”, for advisers recommending listed investment funds to both retail and wholesale clients. These conflicted payments were already banned under the 2012 Future of Financial Advice (FOFA) laws, which reshaped the financial planning market by ensuring advisers were only ever paid by their clients and not by product manufacturers, like fund managers, trying to motivate them to sell their wares to retail and wholesale customers.

The presence of sales commissions paid to advisers created endless mis-selling crises where inappropriate products were foisted on consumers in the name of capturing the associated fees, which FOFA brought to an end. The 2019 royal commission firmly reinforced FOFA’s intent by concluding that “there must be recognition that conflicts of interest and conflicts between duty and interest should be eliminated rather than managed”. Yet in 2014 the Coalition granted listed investment companies (LICs) and listed investment trusts (LITs) an exemption from FOFA.

In contrast to normal unlisted managed funds and exchange traded funds, this meant that a fundie launching an LIC or LIT could pay unlimited sales commissions to retail advisers promoting these products. This has unsurprisingly led to an explosion in fund managers raising tens of billions of dollars from mums and dads for complex hedge funds and junk bond funds by paying advisers enormous upfront sales commissions of between 1 per cent and 3 per cent of the money they source from their clients.

Under FASEA’s new Code of Ethics, which becomes legally binding on all Australian advisers from January 1, 2020, this will no longer be possible. Advisers are already talking about how the code will eliminate the gargantuan sales commissions paid by LICs and LITs and force them to compete purely on their merits like all normal investment products that have been bound by the FOFA laws.

FASEA’s code will also apply to many stockbrokers who these days are more often than not required to be RG146 qualified as a retail adviser.

Magellan presciently anticipated this development by recently raising $860 million for an LIT that paid no commissions to brokers and advisers.

Standard 3 of the code says an adviser “must not advise, refer or act in any other manner where you have a conflict of interest or duty”. It then provides specific case studies under a guidance note of what represents an illegal breach.

One example involves an adviser’s firm taking “advantage of the carve out from the conflicted remuneration provisions introduced by the FOFA reforms” for stockbroking fees. It then says that where an adviser recommends a product to earn extra stockbroking commissions, they breach the standard and cannot do so.

Another case study deals explicitly with the stamping fees advisers capture from IPOs of LICs and LITs. The guidance states that an adviser “keeping the stamping fee rather than…rebating it [is] unfair to [the adviser’s] clients”. “The option to keep the stamping fee creates a conflict between [the adviser’s] interest in receiving the fee and his client’s interests. Standard 3 requires [the adviser] to avoid the conflict of interest. It is not sufficient for him to decline the benefit as it may be retained by his principal. Either the firm must decline the stamping fee altogether, or [the adviser] must rebate it in full to his clients.”

The ban on stamping fees for LICs and LITs for all advisers is therefore black and white. Some advisers have speculated that FASEA’s code might only apply to retail, not wholesale, clients, thereby allowing them to still capture conflicted sales commissions when recommending products to wholesale customers. This column has confirmed that all registered advisers must comply with the code’s standards irrespective of whether they deal with wholesale or retail customers.

This means FASEA’s code extends well beyond FOFA’s reach, which only protects retail investors.

Under the Corporations Act, an individual can be classified as a wholesale client if the adviser can obtain an accountant’s certificate showing they have net assets of at least $2.5 million, or a gross income for each of the past two financial years of at least $250,000. The problem is that many individuals who earn more than $250,000 a year, or have a home worth $2.5 million, know absolutely nothing about finance, investing or markets. This includes scores of retirees who have seen their homes appreciate beyond $2.5 million.

Since roughly 80 per cent of all LICs and LITs are trading below their net tangible assets, with many inflicting large 10 per cent to 20 per cent losses on clients who bought them in the original IPO, advisers open themselves up to catastrophic compensation claims for losses incurred by any clients other than the most sophisticated institutional-style investors.

It would be straightforward for many normal wholesale clients to argue that they do not fully understand hedge funds or leveraged junk bond funds, and relied on their adviser’s recommendation with or without a formal statement of advice.

It would also be easy for them to make the case that the adviser’s recommendation was being influenced by the large conflicted sales commission they received for pushing the product.

Here the guidance note explains that a key legal test is whether “a disinterested person, in possession of all the facts, might reasonably conclude that the form of variable income (eg, brokerage fees, asset-based fees or commissions) could induce an adviser to act in a manner inconsistent with the best interests of the client or the other provisions of the code”.

What is ESG?

As we meet more people around Australia, a common trait and questions continue to be raised around the ability to invest more sustainably and ethically particularly in regards to climate change. This is a theme that has been growing exponentially at the institutional level, but limited coverage or options have been made available for most investors. Given the plethora of acronyms already in the industry, we thought it appropriate to provide a short summary of how people can invest more sustainably through a concept called ESG.  Put simply, ESG stands for Environmental, Social and Governance criteria when it comes to investing. There are many ways to apply ESG principles, which we will discuss in future issues, however, at this point we just wanted to provide an introduction to the sector.

Environmental considerations refer to investing in businesses who are stewards of nature. This may sound a little green, however, in this criteria you are either looking at companies who are aware and managing their energy use, waste, pollution and are actively involved in natural resource conservative in some way within their businesses. Most importantly, businesses must be aware of the environment risks that they are exposed to and have a policy of how to manage those risks including contaminated land, climate change and emissions.

Social considerations are becoming increasingly important in our globalised world, as after years of exporting jobs to access cheaper labour, they are now moving home or into frontier markets. The social considerations refer to relationships with employees, customers, suppliers and communities. The key exposures relate to understanding the supply chain of products being manufactured, avoiding cheap and child labour, donating a portion of profits, allowing employees time to volunteer and offer strong working conditions. A movement called B Corporations is quickly gaining steam in the country, as it requires members to consider all stakeholders in running their business. Wattle Partners has been one of the few financial advisers in the country that is an accredited BCorp.

In recent months, with the likes of Woolworth’s underpayment scandal and Westpac’s Anti Money Laundering issues, Governance has become an increasingly important question. This begins at the top, focusing on the leadership of businesses, appropriateness of executive pay, quality of external audits and internal controls (including whistle-blower policies) and protecting shareholder rights. This extends to maintaining accurate and transparent records, allowing shareholders to vote on important issues and disclosing the conflicts of interest or any board members.

Each of these criteria can be applied on a positive or negative basis, which we will discuss in future issues.

 

The month that was…

  • Whilst it was an interesting month in investment markets, our thoughts and wishes must go to those impacted by the bushfires sweeping Australia. The scale of these fires is unprecedented and this has been brought closer to home with smoke covering Melbourne’s CBD in recent weeks. In an effort to provide any help possible, we have allocated our annual Client Christmas Gift budget to a number of worthy causes related to the bushfires.

 

  • Moving to investment markets, 2019 was one of the strongest years for investment returns since the GFC and the best in a decade. The ASX 200 increased over 18% in price terms, the US S&P 500, 28%, and the Nikkei 225, 18%. This came amid what seemed to be one of the most uncertain, negative and strained economic and social background in recent memory. The key reason behind the strength? A continuation of the trend since the GFC, low interest rates, quantitative easing and money printing, forcing investors into riskier assets for any hope of returns.

 

  • In terms of companies and sectors, it was Healthcare (43%), Information Technology (33%) and Consumer Discretionary (32%) that lead the way in Australia with two of the best performing companies, Fortescue Metals and Magellan Financial (+150% respectively). Global returns were also exceptional, with S&P 500 members, Apple (89%), NVIDIA (77%) and Mastercard (60%) among the top 50

 

  • December saw the UK’s Conservative Party take a resounding victory, re-electing Boris Johnson and his ‘Get Brexit Done’ mission and pushing back against the more extreme policies adopted by the Labour Party under Jeremy Corbyn. This effectively guarantees that Brexit will proceed, with the process of negotiating bilateral trade deals with countries including the US and Australia in full swing. The result was received positively by markets, as everything seems to be these days, removing another potential source of uncertainty and improving the hope of a global economy recovery.

 

  • In another positive sign for the global economy and sharemarkets (not to mention Trump’s re-election chances), the US and China have come to an agreement regarding a number of issues behind their trade war. The so-called ‘Phase One’ deal is expected to double US exports to China, initially from the struggling agricultural sector, and includes better intellectual property protections, curbing of technology transfer to Chinese firms and the expectation that China will further liberalize it’s financial markets. More recently, China’s central Government also released a further $115bn into the economy by once again reducing the capital ratio required of their banks.

 

  • APRA released its long-awaited super fund ‘Heat Map’ in December, attracting the ire of the strongest and weakest performers alike. On first view, it provides a useful reference tool particularly for those in super funds forced onto them by their employers. Looking more closely, however, some dangerous precedents have been set that are based around the near sole focus on historical performance and reported fees, with limited consideration given to transparency or flexibility. The worst performing included Maritime Super, BT Super for Life, and Energy Industry Super, with a number of corporate plans the worst in terms of fees, Pitcher’s, Goldman Sachs and Qantas. It was a busy month for the industry fund sector, with ASIC releasing a report on the quality of financial advice they provide, which concluded that 51% of funds provided non-compliant personal advice to members.

 

  • The Australian economy continues to struggle, with annual economic growth of just 1.7% and a quarterly increase of 0.4%. The performance was once again driven by the consumer, who is spending little on retail but more on services, dining and experiences, whilst falling Government spending was the reason behind the slowdown compared to the third quarter. Australia’s reliance on big business, including traditional banks and retailers, and our lack of innovation is becoming increasing obvious in our economic results. Interestingly, Australian tax on company income is the highest in the world as a portion of GDP. Australia is in desperate need of personal and corporate tax reform. In the US, unemployment fell to 3.5% during the quarter, the lowest level since 1969, with expectations this will have a flow on impact on wage inflation in 2020.

 

  • The Wattle Partner’s Investment Committee have for some time been undertaking due diligence on a climate change and ESG, or Environment, Social, Governance driven portfolio, which will be launched in 2020. Given our research, we were interested to hear Kenneth Hayne’s, famous for running the Financial Services Royal Commission, comments on the issue and where board and management focus should truly be.

 

  • We were intrigued to see GPIF, the Government Pension Investment Fund of Japan with over $1 trillion in assets under management, announce they would no longer be lending stock to short sellers. Lending stock is commonly used by industry funds, index funds and most large managers in order to add an additional level of return associated with the lending fee. GPIF indicated this was worth as much as $573m to them. This comes after a tumultuous year for many Australian companies from Blue Sky to Rural Funds and Wisetech Global.

 

  • “I’m no Skase” read the headline in the Australian Financial Review. The interviewee was the head of IPO Wealth and Mayfair Platinum, two investment opportunities that are being heavily (and expensively) marketed for their income offerings to yield starved Australian investors. The group’s approach appears to involve guaranteeing income returns to investors, on lending their capital to listed and unlisted companies, and hoping they perform sufficiently to be able to repay investor’s capital. In late 2019 they ran an extravagant launch after acquiring the derelict Dunk Island for $135m, of what we assumed is investors capital. If there is a sign of the market nearing high, this may be it.